Sound of relief: IRS provides transitional relief for return preparer penalty.

The IRS recently released Notice 2007-54, providing guidance and transitional relief for the return preparer penalty provisions amended by the Small Business and Work Opportunity Act of 2007. The new amendments are effective for returns prepared after May 25, 2007.

The transitional relief provided by Notice 2007-54 will apply to all returns, amended returns and refund claims due on or before Dec. 31, 2007, including those returns, amended returns and refund claims filed pursuant to extensions to file due on or before Dec. 31, 2007; to 2007 estimated tax returns due on or before Jan. 15, 2008; and to 2007 employment and excise tax returns due on or before Jan. 31, 2008.

Background

The Small Business and Work Opportunity Act of 2007, Pub. L. No. 110-28, 121 Stat.--, (the Act) was enacted into law May 25, 2007. Sec. 8246 of the Act amends several provisions of the Code to extend the application of the income tax return preparer penalties to all tax return preparers, alter the standards of conduct that must be met to avoid imposition of the penalties for preparing a return, which reflects an understatement of liability, and increase applicable penalties.

The amendments are effective for tax returns prepared after the date of the enactment, May 25, 2007.

The amendments made by the Act raise questions regarding activities representing preparation of a tax return, who is a return preparer within the meaning of Sec. 7701(a)(36) (as amended), and how the statute applies to signing and non-signing preparers.

To address these questions, the IRS is considering whether regulations or other published guidance are needed, including, but not limited to, amendments to Treas. Reg. sections 301.7701-15 and 1.6694-0 through 1.6694-4.

Because the Act extends the types of returns subject to the new provisions, changes also are required to the relevant forms and publications. The IRS also must alter existing procedures to process disclosures with certain forms and in electronic formats.

Because the amendments to Sec. 6694 are effective immediately for returns prepared after May 25, 2007, the IRS believes that effective tax administration requires transitional relief with respect to the new standards of conduct under Sec. 6694(a).

Penalty Under Sec. 6694

Prior to amendment by the Act, the penalty under Sec. 6694(a) applied if:

(1) any part of an understatement of liability with respect to any return or claim for refund is due to a position for which there was not a realistic possibility of being sustained on its merits;

(2) any person who is an the income tax return preparer with respect to such return or claim knew (or reasonably should have known) of such position; and

(3) such position was not disclosed as provided in Sec. 6662(d)(2)(B)(ii) or was frivolous.

Prior to amendment by the Act, the penalty under Sec. 6694(b) applied if any part of an understatement was due to:

(1) a willful attempt in any manner by an income tax return preparer to understate the liability for tax; or

(2) to any reckless or intentional disregard of rules or regulations by an income tax return preparer.

Sec. 8246 of the Act amended several provisions of the Code to extend the scope of the income tax return preparer penalties to preparers of all tax returns, amended returns and claims for refund, including estate and gift tax returns, generation-skipping transfer tax returns, employment tax returns, and excise tax returns. The Act amended Sec. 6694(a) to provide that the penalty would apply if:

(A) the tax return preparer knew (or reasonably should have known) of the position;

(B) there was not a reasonable belief that the position would more likely than not be sustained on its merits; and

(C) (i) the position was not disclosed as provided in Sec. 6662(d)(2)(B)(ii) or (ii) there was no reasonable basis for the position.

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Although the Act did not alter the standard of conduct under Sec. 6694(b), it increased the amount of the penalty and made the penalty applicable to all tax return preparers.

Sec. 8246 of the Act amends the standards of conduct under Sec. 6694(a) in two ways.

First, for undisclosed positions, the Act replaces the realistic possibility standard with a requirement that there be a reasonable belief that the tax treatment of the position would more likely than not be sustained on its merits.

Second, for disclosed positions, the Act replaces the not-frivolous standard with the requirement that there be a reasonable basis for the tax treatment of the position.

The Act also increased the first-tier Sec. 6694(a) penalty for understatements from $250 to the greater of $1,000 or 50 percent of the income derived (or to be derived) by the tax return preparer from the preparation of a return or claim with respect to which the penalty was imposed. The Act increased the second-tier Sec. 6694(b) penalty for willful or reckless conduct from $1,000 to the greater of $5,000 or 50 percent of the income derived (or to be derived) by the tax return preparer.

Under both the prior and current law, disclosure under Sec. 6694(a) is adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treasury Regulation sections 1.6694-2(c)(3) and 1.6662-4(f)(2). In addition, under both the prior and current law, the penalty under Sec. 6694(a) would not be imposed if it is shown that there is reasonable cause for the understatement and the tax return preparer acted in good faith.

Transitional Relief

To provide sufficient time to address issues pertaining to the implementation of the Act, the IRS is providing the following transitional relief:

For income tax returns, amended returns and refund claims, the standards set forth under the previous law and current regulations under Sec. 6694 will be applied in determining whether the IRS will impose a penalty under Sec. 6694(a).

Generally, in applying transitional relief for income tax returns, amended returns or refund claims, disclosure would be adequate if made on a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, attached to the return, amended return, or refund claim, or pursuant to the annual revenue procedure authorized in Treas. Reg. sections 1.6694-2(c)(3) and 1.6662-4(f)(2).

For all other returns, amended returns, and claims for refund, including estate, gift, and generation-skipping transfer tax returns, employment tax returns, and excise tax returns, the reasonable basis standard set forth in the regulations issued under Sec. 6662, without regard to the disclosure requirements contained therein, will be applied in determining whether the IRS will impose a penalty under Sec. 6694(a).

This transitional relief will apply to all returns, amended returns, and refund claims due on or before Dec. 31, 2007 (determined with regard to any extension of time for filing); to 2007 estimated tax returns due on or before Jan. 15, 2008; and to 2007 employment and excise tax returns due on or before Jan. 31, 2008.

No transitional relief is available under Sec. 6694(b) as transitional relief is not appropriate for return preparers who exhibit willful or reckless conduct, regardless of the type of return prepared.

CPA Day A Great Event

CalCPA held its second annual CPA Day at the Capitol May 29, attracting 200 participants to the Capitol.

Following a morning briefing, participants met in teams with legislators and other decision makers about peer review, interstate mobility and financial literacy.

Assembly Member Fiona Ma, CPA, welcomed participants during the morning briefing and reminded them that their presence as constituents was critical to making a difference by providing legislators with an important reality check.

We are planning another CPA Day in May 2008. Your participation will be important because we anticipate having legislation addressing the future of the CPA profession in California, including legislation to ease mobility.

Bruce C. Allen is CalCPA's director of government relations.